Bulletin

Insider fallibility

Those 'in the know' aren't always the best to follow, just ask IndyMac holders

By

AriCharney

ANNANDALE, Va. (MarketWatch) -- Longtime investors are likely familiar with the adage that corporate insiders sell shares of their companies for any number of reasons, but they only buy for one reason. Indeed, a number of investment newsletters pay close attention to insider activity, hoping to glean an informational edge from the patterns of insider buying and selling.

But as Mark Hulbert noted in his column last week, even relatively savvy insiders can occasionally get it wrong. See story.

That's the lesson that three investment newsletters may be taking to heart after federal regulators declared IndyMac Bancorp
IMB, +1.92%
under-capitalized last week. The Pasadena, Calif.-based savings bank became the biggest casualty of the subprime mortgage crisis, becoming one of the largest U.S. bank failures ever. See story.

Some may find it surprising that three newsletters on the Hulbert Financial Digest's monitored list still held shares of IndyMac in their portfolios until last week. To be fair, two of these newsletters made opportunistic purchases of IndyMac after the shares had already suffered steep declines. In addition to bargain hunting, both newsletters were also enticed by the fact that insiders, particularly Chief Executive Officer Michael Perry, were committing substantial personal wealth to shares in the company even after the credit crisis was already underway. These confident actions suggested that insiders believed IndyMac would ultimately survive the credit crisis.

John Buckingham, editor of the top-performing Prudent Speculator, anointed IndyMac his "Stock of the Month" in his April 2007 issue, just weeks after Perry purchased more than $1 million worth of shares. The deep-value oriented Buckingham later added shares of IndyMac to a second portfolio in July 2007. In an email hotline last Wednesday night, Buckingham announced he would be selling IndyMac from one of his two portfolios because being deemed under-capitalized, "is typically a death knell for lenders..."

And Vickers Weekly Insider Report, which is published by Argus Research, recommended shares of IndyMac just weeks after Perry purchased over $2.6 million worth of shares earlier this year in February. At the time, Vickers' purchase comprised roughly 10% of its "Risk" model portfolio. With this recommendation, Vickers, which specializes in analyzing insider activity, noted that the brisk pace of insider purchases showed a "reversal of sentiment" on the part of certain insiders. Along with Vickers, the HFD tracks two other newsletters that also use insider activity as the basis for their stock-picking. Neither InsiderInsights nor Jack Adamo's Insiders PLUS recommended IndyMac during the past two years.

While John Dessauer's Investors World has rated IndyMac a "buy" since 2001, Dessauer has repeatedly cited insider purchases as one of the reasons for maintaining his "buy" rating even as IndyMac's share price steadily eroded. In his most recent issue, Dessauer said his confidence in IndyMac's management was bolstered by the fact that insiders' own wealth is on the line. "I look at all the millions of dollars invested in the stock by insiders at much higher prices and see a huge incentive to rebuild IndyMac, in part to restore their personal fortunes," Dessauer wrote. But this past Wednesday night, the usually optimistic Dessauer finally succumbed to the cascade of bad news and announced he would be downgrading IndyMac to a "hold"- at least until the company reports its second-quarter earnings in August.

Given this stark lesson of how insiders can lead investors astray, it may be useful to know about one analysis that Jack Adamo's Insiders PLUS applies to insider purchases. Several times since the inception of the credit crisis, Adamo has suggested that a fair amount of insider buying has been "public-relations motivated."

As such, Adamo has said that he gives almost as much credence to insiders holding onto shares exercised from options packages as he does to insider purchases performed on the open market. "They're less showy (little PR value) and they cause a taxable event, for which the holder has to lay out money," Adamo explained. "If he or she doesn't sell enough to pay the taxes, I deem that a sign the shares are expected to rise substantially within a reasonable timeframe."

Of course, Perry's "showy" purchase earlier this year happened to meet this criterion. Still, it's important for investors to be able to divine the intent of insiders even when allowing for those rare instances when insiders make good faith bets that go wrong.

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